I was offered today to sell a home I have for 70,000. They offered 10,000 down and 502.00 month for 25 years, or another offer for 70,000 cash. What would youu experts take. In the end where will I make the most money and less taxes paid.
Thanks and they both want an answer now and I am stalling as IO am not sure which to do. Pay the 33% profit or take interest over many years??
anyone??
How long have you owned the house? What did you do with it while you owned it? What is the interest rate they are paying for your financing? Do you need the money right now? Do you have a mortgage on this property, yourself?
Answer these questions.
Given a choice of two watches, would you pick
A. one that gives the correct time only twice a day, or,
B. one that gives the correct time only once a month
Try this one.
Given a choice of two watches, would you pick
C. one that loses one minute per hour, or,
D. one that is broken and does not work at all
I suspect you picked A and C. If you picked A, then a watch that only gives the correct time twice a day, is a broken watch. If you picked C, then you picked a watch that only gives you the correct time once a month.
You question is similar to the two watches, you can either have a broken watch or a watch that is correct once a month. You ask which offer makes you the most money and which pays the least in taxes. You make the most money by selling on terms. You pay the least taxes by selling for lump sum cash. If you can’t have both, which do you want?
How long have you owned the house? What did you do with it while you owned it? What is the interest rate they are paying for your financing? Do you need the money right now? Do you have a mortgage on this property, yourself?
3mths,rented,8.99,yes,yes
What is the longest years you would owner finance?
3-5 yrs. on a land contract then a balloon payment.
1-2 on a lease option.
Bottom line though, I love Cash Now.
my 2 cents.
herbster
You say you need the money right now, but you put a rentar in place. Seems to be a contradiction. If you need the money from the sale right now, then your only option is the lump sum cash offer.
To compare offers you have to convert everything to its present value. The cash offer is simple it is worth $70,000 today. The financing offer requires you to make an assumption about an appropriate discount (interest) rate. I’ll assume the going rate for owner financing is 8%. So discounting the monthly payment of $502 over the next 25 years back to its present value today you get about $65,000. Add to this the $10,000 down payment and your financing deal has a total present value of $75,000.
As for which offer reduces your tax burden I am not an accountant but here is what I see. Selling for cash today will generate some gain on sale assuming your basis is less than $70,000. Since this is an investment property that gain on sale will be fully taxable at your marginal tax rate in the current year. Selling on terms creates a larger gain on the sale but this gain will be spread over the life of the note (I believe).
I agree that a Present Value analysis is a correct approach to compare the two sale options, however, I disagree with your discount rate. I don’t believe inflation will average 8% over the next 25 years. I think 4% is a more realistic estimate, although that may also be a little conservative.
You are correct that a lumpsum payment of $70K today is worth $70K. For the installment sale, we need to calculate what 300 future monthly payments of $502 is worth today, or to say it another way, how much would I need to receive in a lump sum today to have the same purchasing power as receiving $502 per month for the next 300 months.
Changing the discount rate to 4% for the present value analysis to reflect the probable inflation rate, I calculate that receiving $150600 in 300 monthly installments has the same purchasing power as receiving one lump sum payment today of $95105.
Add in the $10K downpayment, and the installment sale has a PV of $105105 vs the lumpsum cash sale PV of $70K. Of course, this assumes that the buyer does not sell the property before the loan term is over, and, does not refinance the loan in a couple of years.
Just in case the buyer decides two years from now that an 8% interest rate is too high and decides to refinance, let’s see what the present value looks like after 24 months of payments at $502 each, and one balloon payment of $58364. Using the same 4% discount rate, it turns out that the PV for a two year loan with a balloon payment at the end is $65444. Add in the $10K upfront downpayment, and the PV for this exit strategy is $75444.
DaveT,
We seem to view this question from different perspectives. I chose the 8% discount rate not as a surrogate for the rate of inflation but as an estimate of an owner financing rate. The original post offers two options; cash now or financing terms. To value those terms I would apply a discount rate that rewards me for the risk taken. Perhaps I would start with a risk free rate alternative investment and add to that a premium for the credit and liquidity risk of holding the note. Or as my example look at current mortgage rates and add a premium to that for acting as the bank. Thus in my analysis the value of $502 over 25 years equates to $65k using an 8% discount rate. Obviously any discount rate is debatable, this is just my perspective and how I analyze deals.
If you are happy with the $70,000 price, take that.
A bird in the hand… There is no guarantee you will see the monthly payments, and you sure don’t want to carry for 25 years. 25 years from now, that $500 a month payment won’t be enough to purchase a can of soda.
1031 to save the taxes.
71tr,
I honestly do see where you are coming from, but I don’t quite see how your analysis helps ruready choose which option to take. If you use the 9% interest rate that he is being given for his seller financing as your discount rate, then you come up with $60K for the PV of his note.
In option two, ruready is being asked to carry back $60K in financing at a presumed rate of 9% resulting in a monthly income of $502 until the loan is paid off. Of course, I am assuming that this is a fully amortizing loan over 25 years.
The question to ask ruready is, could he do better if he took the lump sum cash payment option instead of the seller financing. Can he get better than a 9% return on his investment if he had the $60K in his hand to invest today?
If the answer is yes, then he should take the lump sum payout. If the answer is no, then the seller financing should be his default choice.
Remember his first question is which option lets him make the most money.
Could I do a 1031 if it is a rental? Could I get a LLC from NV thats supposed to be cheaper just as legal as if bought in NC? I might sell house for 70,000 w/ 10,000 down and 20 year finance for 538 mth. 9% interest. I haven’t had this rental a year so I hope I will only have to pay taxes as much as I have received by the end of the year.
I was wondering what was an average cost foreclosing on a prop? I want to have buyer sign something to the effect that if they don’t make payments that it gets signed back to me. Does that sound like a good idea to you guys? I am not expecting them to foreclose but want to not be shocked of cost and so forth
Could I do a 1031 if it is a rental?
Yes, you could but only if you take the lump sum payment option. A 1031 exchange is not an available tax treatment if you seller finance the deal.
Could I get a LLC from NV thats supposed to be cheaper just as legal as if bought in NC?
Yes you could, but if your LLC does business in NC, it will also have to be registered in NC. Why bother with an LLC in the first place? It will just get in the way of selling this property, cost you more money out of pocket, and won’t save you a penny in income taxes.
I might sell house for 70,000 w/ 10,000 down and 20 year finance for 538 mth. 9% interest. I haven’t had this rental a year so I hope I will only have to pay taxes as much as I have received by the end of the year.
An installment sale does not save you any income taxes. It only lets you pay your tax bill in installments, but by doing so, you may pay more than you would otherwise.
Realize that the unrecaptured depreciation will be paid first. The initial downpayment and any installment of principal you receive in the year of sale, will first be applied to unrecaptured depreciation (taxed at 25%). Once the tax on unrecaptured depreciation is paid in full, any left over sale profit is taxed at your ordinary income tax rate as well as the interest you receive on your loan.
Should you make a lot of money in a future year which puts you into a higher marginal tax bracket, any installments you receive that year will be taxed at the higher bracket amount. Conversely, if you fall into a lower tax bracket, you will benefit from a lower tax bracket rate on your installment payments.